Monetary Policy

The Upside-Down World of Negative Interest Rates

Imagine a world of negative interest rates. Instead of paying you interest on deposits, your bank would charge you for storing cash in its vault. Instead of waiting until the last minute to pay your bills, you would pay them as quickly as possible in order to reduce the cash in your checking account. People would keep cash at home instead of in the bank. For the sake of convenience, they would clamor for denominations bigger than the $100 bill.

Garbade and McAndrews wrote the note in response to proposals for the Federal Reserve to impose negative interest rates on banks, proposals aimed at compelling banks to lend money instead of hoarding it in their reserve accounts at the Fed. Currently, the Fed pays banks 0.25 percent annually on their excess reserves. Princeton University economist Alan Blinder, among others, has proposed flipping that around and charging banks 0.25 percent on their reserves. That would be a negative interest rate.

In their research note, the New York Fed economists take no position on Blinder’s idea. They don’t even directly address it, choosing instead to study the possible effects of an interest rate below negative 0.5 percent, which would obviously be more distortional than Blinder’s quarter-point proposal. Still, they make it clear that negative rates would shake up the financial system in ways that may not be immediately obvious. Under “significantly negative” rates, they say:

—”The largest denomination bill available today is the $100 bill. It would take ten thousand such bills to make $1 million. Ten thousand bills take up a lot of space, are costly to transport, and present significant security problems.”

—Special-purpose banks would spring up, holding nothing but cash “in a very large vault.”

—”A taxpayer might choose to make large excess payments on her quarterly estimated federal income tax filings, with the idea of recovering the excess payments the following April.”

—”A credit card holder might choose to make a large advance payment and then run down his balance with subsequent expenditures, reversing the usual practice of making purchases first and payments later.”

—”I might even go to my bank and withdraw funds in the form of a certified check made payable to myself, and then put that check in a drawer.”

—”People receiving payments will prefer checks (which can be held back from collection) to electronic transfers.”

Blinder, reached by phone on his way to the Jackson Hole, Wyo., monetary policy conference, says the New York Fed paper is irrelevant to his proposal because it considers a more extreme action. “They’re talking about far more drastic scenarios than anyone I’ve heard of is contemplating,” he says.